A market correction in the financial market is when there is a pullback in stock prices, and it can be regional or global in nature. Typically, a correction is represented by a short-term drop in market prices that might be attributed to extraneous circumstances unrelated to underlying financial conditions of a stock. During a correction, stocks typically lose 5 percent to 20 percent of their value in a matter of weeks or months. There is no one way for investors to play a market correction correctly, although there are certain strategies that could work if the investor is in a financial position to make changes.
During a market correction, most all stocks lose value, ranging from poor-performing securities to industry leaders that have otherwise stood the test of time. Because both groups can be battered during a short-term drop, one way to play the markets is to sell some of the weaker names in a portfolio, stocks that were not stellar performers even prior to any correction. In addition to lackluster performers, a market correction might also be a good time to unload stocks that are risky. A pullback in the financial markets is a good time to evaluate one's risk/reward profile, and a market correction serves as a reminder that risky investments can be damaging to a portfolio during certain cycles.
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Because high-quality stocks are most likely trading at a discount during a downward market trend, investors can use this opportunity to buy expensive stocks while they are on sale. Profits generated from selling weak or risky investments might be redirected to high-quality securities. As long as the economic fundamentals of a company are strong, including sales and profits, a stock might be unduly punished during a market correction. This is because either fear or some other short-term event is driving buying and selling activity, but once the dust settles, a solid company is most likely in position to rebound. By investing during a downturn, investors are in place to reap forthcoming profits.
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Investors might opt to exit the stock market when market prices become depressed. Instead of investing in stocks, they might flock to safer asset classes, such as bonds, which pay a fixed income amount to investors over a period of time. This is a fine way to play the markets as long as bonds are yielding respectable returns. If, for instance, the interest rates on bonds are equivalent or below what a savings account is yielding, there is little incentive to transfer risk from stocks to bonds.
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